In this chapter, we examine labor market structure as an explanation of the persistent geographic differences in unemployment rates in the United States. Specifically, we focus on the insurance role that diversified labor markets can play. It is sometimes argued that employment variability has increased in the 1970s and 1980s and that this has led to higher aggregate unemployment and greater dispersion in local unemployment rates. A related view of the effect of labor demand variability on unemployment recognizes that the equilibrium level of unemployment in a labor market is partially determined by uncertainty about current and future states of labor demand. For example, in competitive models with costly search among spatially distinct “islands,” an increase in the variability of labor demand will increase the amount of search unemployment and increase mobility (Lucas and Prescott 1974). Neither view provides an explanation of the two central empirical facts about geographic unemployment rates: (1) Unemployment rate differences persist over time, although the actual levels vary, and (2) migration does not appear to be affected by differences in labor market unemployment rates. The goal of this chapter is to provide a consistent explanation of both empirical findings.

The plan of the chapter is as follows. In Section 11.1 we present a simple one-sector contracting model that illustrates the essential aspects of labor force allocation under uncertainty.